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Sunday, April 09, 2006

Julian is still right....

Aruni Mukherjee, of the University of Warwick, has an interesting article in The Asia Times. He recounts the famous---infamous in Green circles---between Julian Simon, an economist and Paul Ehrlich, one of the most famous doomsday prophets of the Green religion.

Simon argued that the price of resources were on a long term downward trend. I think he is absolutely right. Ehrlich argued that we are running out of everything. Now basic economics, on which no sane economist disagrees, tells you that if a resource is becoming scarce relative to demand that the price will go up. And if the supply is becoming more plentiful, in economic terms, the price will drop.

Ehrlich's predictions regarding, well actually regarding almost everything he ever predicted, have been spectacularly wrong. If he got anything right I'm unaware of it. He predicted massive famine in Vietnam and by the time his book had been published with this claim Vietnam was already producing food surpluses and that was some years ago. It still is producing food surpluses. Ehrlich knows nothing about economics at all and that is the core reason that he keeps making a fool out of himself. Of course the true believers in the Green religion, like fundamentalists everywhere, will never worry about such things. They just ignore the facts. When it comes to facts versus faith the religious prefer faith.

The reason I bring up Mr. Mukherjee is that his article looks at this debate once again. Now originally Simon argued that Ehrlich could pick any 10 resources and they would calculate how much of the resource one could buy for $1000 in 1980, the year of the bet. In one decade they would take the same quantity of those resources and convert it into dollars. Only as an example let us assume that for $1000 you could buy 500 pounds of copper in 1980. In 1990 they then take the 500 pounds of copper and look at the price for copper and convert this back to a dollar amount. So if 500 pounds of copper in 1990 were worth $1200 we would say that copper has become more scarce. If, instead, it were selling for $800 then copper became less scarce.

As the bet went the difference between the value in 1980 and 1990 would be paid to the winner by the loser. So in the fictional example I gave if the price went up to $1200 then Simon would pay Ehrlich $200 ($1200 less $1000). If the price dropped then Ehrlich pays the difference to Simon. Ehrlich bragged about how easy it would be for him to make a nice sum of money from such an easy bet. In his uninformed view the world could only be running out of things and prices had to go up. He saw it as a sucker bet.

It was. He, however, was the sucker. The price of every single resource that Ehrlich picked out dropped. And the drop was so dramatic that even without adjusting for inflation Simon would have won the bet. What makes Mukherjee's article of interest is that he wondered what would have happened if they had extended the bet until today. Now Simon offered to place a second bet with more resources for an even longer time period but Ehrlich, once burned, refused to consider it. He made some snide remark about the bet proving nothing and then pretty much pretended it never happened.

Now Simon never said such drops were linear. Prices go up and down. And there can well be circumstances unique to one resource which pushes it up for a period. But he argued that long-term the general trend is for prices to drop. Remember everything has to be adjusted for the fact that government keeps lowering the value of money through inflation. Simon thought it was possible to be wrong here and there which is why he picked several items and not just one. Mukherjee found that if the bet had been extended to the end of last year that Simon still would have won. All the prices were still below the 1980 value. So Ehrlich was wise to refuse to accept another bet. Unfortunately Dr. Simon did live long enough to see these results. Ehrlich still peddles the same old theories he did before. As I said faith trumps facts for the true believers.

Mukherjee also discusses a more recent bet by New York Times columnist John Tierney. Tierney is a fascinating writer and I used to read him all the time. But his paper has now made his column a "premium service" so I don't read him any longer. And I rarely mention columns that appear in the NY Times. The paper made the choice to remove themselves from on-line debate by hiding behind a wall of premium charges. Tierney argued that oil would drop in price long term as well. And he now has a bet with "peak oil" believer Matthew Simmons. Each is putting up $5000 in oil. Tierney argues oil prices will drop long-term and Simmons says it will rise to over $200 per barrel in 2005 dollars.

So far, after adjusting for inflation, Tierney is winning in spite of what are seen as high oil prices. Oil has in fact dropped 3.5% since the bet was made. Now everyone knows that oil is expensive right now due mainly to political factors not to supply factors. But Mukherjee notes that if one adjusts the old prices of oil so that we are using dollars of the same value that oil has dropped in price since the Simon bet. A barrel of oil in 1980 would have fetched $85.61 in 2005 dollars. In 2005 it was going for around $55 which is a drop in price of about 3.5%. And if you go back to 1970 the price drop has been even more dramatic.

Tierney has taken a bigger risk. He is not betting on a basket of resources but on just one resource and one that is particularly susceptible to political manipulation. One stupid invasion in some Middle Eastern nation could send oil prices back through the roof. A series of terrorist attacks on oil fields could do the same thing. One of the richest oil fields in the world, in Venezuela, is under the control of a Marxist nutcase. Presumably Tierney feels that by holding the bet long enough that the time factor will smooth out the rough bumps that politics can create. Tierney could be very right in the long-term (and I think he is) and still lose the bet in the short-term. But a pure Simonian perspective wouldn't have this problem as a basket of resources would be chosen and not just one.

So even if Tierney loses the bet the theory remains unchallenged only because it was a bet in conflict with the basic tenet of the theory. Yes, long term the costs of resources, in stable dollars, will probably decline. But each resource has separate supply and demand factors. But long-term, on average, prices will decline for virtually any basket of resources one picks. If Tierney loses the Greens will ignore the fundamentals of the theory and crow that this proves they were right all along. And that is the one reason I am not totally happy with Tierney's bet.

I do think he has a very good chance of winning it. But he put all his eggs into one resource basket so to speak. And with just one resource chosen he has a greater chance of being wrong on the specific date when the bet ends. Over time he will probably be proven right but he could well be wrong on that specific day. In fact I would argue that within the life time of people now alive that the price of a barrel of oil, in steady dollars, may well reach a level that is the equivalent of $5 per barrel. Why? Because I think that the day is not far off when most the world will have found other cheaper alternatives for producing energy and the demand for oil will drop to a fraction of what it is today. Much the same way that whale oil dropped in value when people figured out how to use petroleum.